Becoming a home owner is a dream come true for most people. Unfortunately, you will usually have to apply for a mortgage in order to become a home owner. Mortgage loans come with advantages and disadvantages. One of the main disadvantages is that your credit score may be damaged during the home buying process. To become eligible for a mortgage loan and receive the best rates from your lenders, you will have to make sure that your credit score is high enough. After you have bought a house with a mortgage loan, you may want to buy a car or apply for a new credit card. But that may prove more difficult than before, as a new mortgage could lower your credit score. There are three ways in which buying a home by taking out a mortgage loan can hurt your credit score.
Credit Score Inquiries
When applying for a mortgage loan, you will be scrutinized carefully by possible lenders. They will look at your employment status, your salary, your debt-to-income ratio and, most importantly, at your credit score. Your credit score will make the difference between receiving a low interest rate, a high interest rate, or no loan at all.
The lender verifies your credit score by pulling your credit report. The consequence of having your credit score checked by a lender is a drop of 5 or less points. These inquiries will also be added to your credit report, where they will remain for two years. Your credit score will decrease whether you were approved or rejected for the mortgage loan.
New Large Debt
A new mortgage loan will be added to your credit report as a new large debt, which will decrease your credit score significantly. Applying for a new loan or a credit card after you have taken out a mortgage loan will be difficult, as most lenders will consider you a bigger default risk.
The good news is that, even if this score drop will be quick and significant, your credit score will come back to its initial value within six months after taking out the loan, with the condition that your monthly payments are made on time, you keep your account balances low, and take out new loans only if it is absolutely necessary.
Late or Missed Monthly Payments
Repaying a mortgage loan is a big responsibility, and late payments can have a large negative impact on your credit score. Even worse, missing payments can result in losing your home to foreclosure, as has happened to many people in recent years.
Payment history represents 30 percent of your credit score, and a large part of your payment history is represented by your mortgage. Because the mortgage loan is such an important part of your payment history, even a couple of missed monthly payments can lead to a large decrease in your credit score.
You should know that, while a new mortgage loan may decrease your credit score, this is usually only temporary, and your credit score will recover or even increase after a few payments are made on time. So, in the long term, a mortgage will actually be beneficial to your credit score, provided that you make monthly payments on time and don’t miss any.
Mortgage loans and credit scores are closely related. It is your duty, as a prospective home buyer, to know and understand what your financial situation is, and act accordingly. Taking out an affordable mortgage loan and making payments on time will make the mortgage work to your benefit, and even increase your credit score over time.